People Are Talking About A National Debt Solution That Might Actually Make Your Brain Hurt

I met a European trader in a bar this week, who brought up the possibility that at some point, the Bank of England might just rip up the UK government debt it has acquired through quantitative easing -- just straight up throw it on the fire, and tell the government it no longer owes the money.

The Bank of England -- just like the Fed -- has bought a ton of UK government debt as part of its attempt to juice the economy.

So the bottom line is that this shocking move is being talked about by influential publications, Wall Street traders, and perhaps even officials, though they're mum on something so radical.

As the person I talked to put it: It's really hard to see what would be so bad about it. Would the entire system of finance collapse? There's just no reason to think it would.

Probably the worst thing to come out of it would be inflation. Right now, the Fed or Bank of England "prints" money in QE, but for every $100 injected into the system, $100 in equivalent securities are sucked out and put on the central bank's balance sheet, so basically it's a wash. This is why, despite the gigantic expansion of the balance sheet, inflation has been muted and (at least in the US) the trend remains towards disinflation.

Ripping up the bonds would make QE a tad more like "Helicopter Money" since there would be no mechanism for the central bank to sell the bonds back into the market, and sterilize the easing once the economy picked up (though the central bank would have alternate measures to tighten).

The idea of just canceling the debt, however, makes people's heads hurt, because then it feels as though the government can spend with a free lunch. If it's just one arm of the government (the central bank) financing the other arm of the government (the Treasury) then what's the point of even talking about debt, or the need to borrow and so forth?

Thinking about the Fed ripping up the debt is the monetary equivalent of taking the Red Pill in the Matrix. It gets your mind thinking about government finances in a way that you might just prefer not too. It might shake all your assumptions about the national debt to the core, if you started thinking it were that easy to "solve it."

For this reason, we doubt it's going to happen anytime soon. We'd also add, that seeing as debt is not a real "constraint" in the US or the UK (except politically) there's no impetus for either central bank to actually do this. Rates are low, and both countries can spend at will.

Again, it's mostly just a thought experiment that you might not want to try.